Why we haven’t invested in ‘Impact Measurement’ tools, yet...
Our take on this fledgling industry, written by David de Heus
The Hague, The Netherlands - We all know that in order to prevent global warming, companies have to take action. But how do you act without knowing what your impact is? This is where the newly emerged sector “Impact Management & Reporting'' comes into play. Ventures operating in this sector help to measure a company’s impact and provide ways to improve it, while communicating their progress. Even though the industry has only recently been established, we have come across more than 40 ventures operating in this space! Some of these have completed substantial raises, with Persefoni having raised a $101M Series B in Oct-21, Sweep a $73M Series B in Apr-22, and Watershed a Series B of $70M in Feb-22.
What’s leading investors to back these large fund raises?
The main driver accelerating this fledgling industry is the introduction of regulation, triggering annual forecast growth of 29% CAGR from 2023 to 2026. The two most transformative regulations in the EU are the Corporate Sustainability Reporting Directive (CSRD), and the Sustainable Financial Disclosure Regulation (SFDR). These regulations oblige many companies to report on their non-financial impact, something most haven’t done before.
In April 2021, the EU commission adopted the CSRD, in line with the commitment made under the European Green Deal. This regulation requires all “large” companies and listed SMEs to meet the double-materiality principle, reporting on their sustainability under an ESG framework. Reporting also needs to include forward-looking information, such as strategy, targets and progress. This directive applies to roughly 50,000 companies in the EU. Implementation of the regulation will be in tranches, with the first companies having to report in FY 2024. Assuming a conservative average annual spend of c. €20,000 this implies a market opportunity of more than €1 billion in annual revenues.
The SFDR is specifically aimed at Financial Market Participants (FMPs), and being a relatively new concept, it remains open to some interpretation. What is clear is that FMP’s must disclose how ESG factors are integrated both on an entity and a product level. As a result, all companies with investors who fall under the SFDR will also be pushed to disclose their non-financial sustainability information. This creates a snowball effect, expanding the extent of non-financial disclosure and multiplying the market potential with respect to Impact Management & Reporting to a multibillion Euro opportunity.
Since those who now need to report under these new regulations typically have no experience of collecting and reporting on this kind of information, the services of Impact Management & Reporting companies are in demand.
What do these services actually comprise and what are the options?
Companies within the sector can differentiate themselves using various measures, but despite the variety of focus areas, it is challenging to distinguish between the multiple players in this market. Specifically, how do we spot the winners? We have identified various dimensions:
Purpose: management vs. reporting
The three big fish mentioned before, Persefoni, Sweep and Watershed, are primarily management tools (that do some reporting). The focus here is on internal use, such as showing your impact to investors and employees, and demonstrating your progress.
Greenomy, on the other hand, focuses mostly on the accounting side of things, and subsequent reporting. Good to note, this dimension is more like a continuum, where companies are often somewhere between being a full management or reporting tool.
Furthermore, Treety, 414 and Climax cater to financial institutions specifically, whereas Carbmee is aimed at emission intensive industries.
Automation: Manual assessments and consulting services vs. integration, APIs and full automation. Being investors in scalable software solutions, we naturally favor the latter!
Again, companies could well fit between these two extremes, with some companies providing consulting services alongside an automated calculation tool.
Is measuring impact also considered delivering impact?
As an investment opportunity, there is another important question that we at 4impact face. Do these businesses qualify as impact investments? At 4impact, we work with our portfolio companies to define their impact in an impact thesis, including setting impact KPIs and targets. This is only possible if the impact is intentional, additional and can be measured and monitored over time. Does measuring and communicating impact qualify? Even though we believe measurement leads to awareness, which is a vital first step in the process of change, quantifying the outcome is not always straightforward. That being said, there are ways to measure this impact, which would then satisfy our mandate. One viable mechanism is to monitor sustainability metrics for clients via cohort analysis, which allows the startup to monitor and report on the change in sustainability metrics for their clients over time.
Would we invest?
In conclusion, we observe a new and fast-growing industry, largely driven by increased regulation with some companies in the space raising substantial amounts of funding. Many of them, however, are offering very similar services to one another. Would we invest? The first filters for our fund are to see clearly measurable impact enabled by a tech-driven solution. Assuming those features are in place, for early-stage investors such as 4impact, we believe the opportunities lie with the very focused startups. This relates to businesses targeting a specific customer segment with a differentiated customer proposition, in a segment which is large enough to offer meaningful upside. Nevertheless, this strategy needs to be overlaid with a crystal clear go-to-market strategy to counter the low defensibility of these companies. In other words, the bar is set high and we will probably pass on many startups before potentially finding the right opportunity!